Problem #2: passive investors in the real world mechanically need to transact with active investors — they can’t avoid this reality unless they are a mythical “representative agent” in some wack-job theoretical asset pricing model.

Passive is a great thing for the investment public and the ability to access exposure to generic market risks at low costs is an incredible innovation in financial services. We consider Jack Bogle a God in the financial services space. But even Vanguard is aware of their vulnerability in the market. See Vanguard’s presentation to the SEC here.

The WSJ piece merely highlights that active investing IS NOT a zero sum game where active players simply steal alpha from one another.

The gross “alpha” comes from services they are providing to passive investors. Lunch is rarely free in a competitive market.

But gross alpha doesn’t mean investors benefit from active management. We also think that costs matter — always. But so do value propositions.

For example, active management never works if the costs are too high for the long-term expected benefits being delivered, however, affordable active might be a win-win.

Bottomline: know what you are buying and why you are buying it.

The views and opinions expressed herein are those of the author and do not necessarily reflect the views of Alpha Architect, its affiliates or its employees. Our full disclosures are available here. Definitions of common statistics used in our analysis are available here (towards the bottom).

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After serving as a Captain in the United States Marine Corps, Dr. Gray earned a PhD, and worked as a finance professor at Drexel University. Dr. Gray’s interest in bridging the research gap between academia and industry led him to found Alpha Architect, an asset management that delivers affordable active exposures for tax-sensitive investors. Dr. Gray has published four books and a number of academic articles. Wes is a regular contributor to multiple industry outlets, to include the following: Wall Street Journal, Forbes, ETF.com, and the CFA Institute. Dr. Gray earned an MBA and a PhD in finance from the University of Chicago and graduated magna cum laude with a BS from The Wharton School of the University of Pennsylvania.

The extreme situation – all passive, no active – is of course impossible. But an interesting question – and I would be curious, Wes, as to your guess – is when we cross the rubicon (i.e., at what percentage passive do the economics of passive start to deterioriate)?

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Performance figures contained herein are hypothetical, unaudited and prepared by Alpha Architect, LLC; hypothetical results are intended for illustrative purposes only. Past performance is not indicative of future results, which may vary. There is a risk of substantial loss associated with trading stocks, commodities, futures, options and other financial instruments. Full disclosures here.